Chapter 15: Share-based payment award

The amount of replacement share-based payment award that relates to post-combination services is a payment for services, and it is charged to the post-combination income statement.

Acquisition-related costs

An acquirer in a business combination typically incurs acquisition-related costs, such as finder’s fees, advisory, legal, accounting, valuation, other professional or consulting fees, and general and administrative costs. Acquisition-related costs are considered separate transactions and are not part of the consideration transferred. Acquisition-related costs represent services that have been rendered to and consumed by the acquirer. They are accounted for as an expense when the acquirer consumes the related service.

An entity might issue financial instruments that will form part of the consideration transferred for the acquired business. These are accounted for under IAS 32 and IFRS 9. Costs related to the issuance of financial liabilities are capitalised and amortised into profit or loss over the term of the debt, in accordance with the effective interest method. Costs related to the issuance of equity reduce the proceeds received from the issuance and are recorded in equity.

Reimbursement provided to the acquiree or former owners for paying the acquirer’s acquisition costs

Acquisition costs embedded in the consideration transferred are accounted for separately from the business combination. For example, consideration transferred by the acquirer, that includes amounts to reimburse the acquiree or its former owners for payments made on behalf of the acquirer for its acquisition-related costs, are recognised separately from the business combination. These will reduce the amount of consideration and goodwill.

Determination of whether fees paid to an investment banker to handle the financing of a business combination are considered acquisition-related costs

Fees paid to an investment banker in connection with a business combination, where the investment banker is also providing interim financing or underwriting services, must be allocated between direct costs of the acquisition and those related to financing or underwriting the business combination. For example, entity A acquires entity B for 70% cash and the balance in preferred shares and debt, and entity A hires an investment banker to handle the financing and underwriting services.

The costs paid to the investment banker should be allocated between those that related to financing or underwriting the business combination (generally recorded as part of the cost of the debt or equity issuance), and all other services should be expensed as incurred.

Accounting for assumed liabilities for transaction costs incurred by the seller in connection with a business combination

Entity A acquired 100% of entity B. In connection with this transaction, entity B incurred costs to sell the business, including legal fees. As of the acquisition date, entity B had several outstanding invoices to the attorneys and other advisors that assisted with this sale recorded in its acquisition-date balance sheet. The costs incurred by the seller were not for the benefit of the buyer.

Should entity A recognise the outstanding payables of entity B as assumed liabilities in acquisition accounting? Analysis Yes. Acquisition-related costs incurred by an acquirer are considered separate transactions and should be expensed as incurred. However, in this fact pattern, these costs were incurred by the seller for its own benefit.

Therefore, provided that the outstanding payables do not include any of the acquirer’s acquisition-related costs (that is, entity A and entity B did not negotiate for entity B to pay for entity A’s transaction costs), entity A should recognise the outstanding payables as assumed liabilities in acquisition accounting in the same way that entity A would assume entity B’s other accounts payable balances from normal operating activities. If entity A and entity B did negotiate for entity B to pay for entity A’s transaction costs, such costs would be outside the business combination. Therefore, the reimbursement provided by entity A would not be consideration transferred, and an expense would be recognised by entity A in the period when the costs were incurred.

Financial instruments entered into by the acquirer in contemplation of a business combination

An acquirer might enter into financial instruments to hedge certain risks in contemplation of a business combination. Hedge accounting for a firm commitment to acquire a business is prohibited under IFRS 9. However, IFRS 9 does allow entities to achieve hedge accounting for the foreign currency exchange risk embedded in a firm commitment.

Generally, hedges of foreign exchange risk will not be eligible for hedge accounting under IFRS, even though they might effectively hedge various economic risks and exposures related to the transaction. A forecast transaction can qualify for hedge accounting under IFRS 9 only if it is highly probable.

The ability to support an assertion that a business combination is highly probable to occur, and to achieve hedge accounting for these types of hedges, will be rare, given the number of conditions that typically must be met before an acquisition can be completed. Examples of conditions are satisfactory due diligence, no material adverse changes/developments, shareholder votes and regulatory approval. An evaluation of the specific facts and circumstances would be necessary if an entity asserts that a forecast acquisition is highly probable of occurrence.

Application of hedge accounting

The fair value movement on the hedging instrument is accumulated in equity until the date of the business combination, in those rare circumstances where the criteria are met and cash flow hedge accounting is applied. The question arises as to how to treat this amount where the hedging instrument is closed out on the date of the business combination. Any cash paid or received on the hedging instrument is not part of the consideration paid to the seller. However, the IFRS IC concluded that the amount would be treated as a basis adjustment to goodwill (that is, it is included as part of the consideration payable).

Hedges of other items in contemplation of a business combination (for example, the forecast interest expense associated with debt to be issued to fund an acquisition, or the forecast sales associated with the potential acquiree) also do not generally qualify for hedge accounting, and they should be accounted for separately from the business combination. As with the hedge of foreign currency exchange risk, while it could be argued that hedge accounting should be acceptable theoretically, practically it might not be possible to achieve, given the requirement for the forecast transaction to be highly probable.

Repayment of acquiree’s bank debt at the time of a business combination

Business combinations are often accompanied by a change in financing for the acquiree.

Settlement of debt between acquirer and acquiree

An acquiree might have borrowed money from the acquirer. A debtor relationship between the acquiree and acquirer is another form of pre-existing relationship. If the pre-existing relationship is a debt issued by the acquirer to the acquiree, the guidance in IFRS 9 is applied. If debt is settled (extinguished) before maturity, the amount paid on settlement of the debt might differ from the carrying amount of the debt at that time.

An extinguishment gain or loss is recognised in the income statement for the difference between the re-acquisition price (either fair value or stated settlement amount, if any) and the carrying amount of the debt.

For example, if the acquiree has an investment in debt securities of the acquirer with a fair value of C110, and the carrying amount of the acquirer’s debt is C100, the acquirer recognises a settlement loss of C10 on the acquisition date (based on the assumption that the debt was settled at C110).

If the pre-existing relationship effectively settled is a debt financing issued by the acquiree to the acquirer, the acquirer is effectively settling a receivable, using a similar methodology to that described above.

Repayment of acquiree’s bank debt at the time of a business combination

There can be many reasons for the repayment of the acquiree’s bank debt; for example: the acquirer wishes to change the acquiree’s lenders, in order to bring its new subsidiary into line with the group’s banking arrangements; the acquiree’s bank debt includes a change of control clause triggering repayment on the business combination; or the acquirer wishes to buy the acquiree debt-free, so the repayment is written into the sale and purchase agreement.

The acquirer might pass cash to the acquiree in order to repay third-party debt on the business combination. Alternatively, the acquirer might pay the bank directly. Because this is a cash cost to the acquirer group, it might be viewed commercially by the acquirer as part of the consideration for the business combination.

However, since this is not part of the consideration transferred to the seller in exchange for control of the acquiree, it cannot be treated as part of the consideration for the business combination, from an IFRS 3 perspective. This is because paragraph 51 of IFRS 3 requires amounts to be treated as separate transactions if they are “not part of what the acquirer and the acquiree (or its former owners) exchanged in the business combination, ie amounts that are not part of the exchange for the acquiree”.

The impact on the business combination accounting is illustrated in the example below. The classification of such transactions in the cash flow statement should be determined in accordance with IAS 7, and this is considered in chapter 7 para 37.

Example – Repayment of acquiree’s debt as a result of a change in control clause

Target Y has identifiable net assets, excluding debt, of C5 million. It also has third-party bank debt, which has both a book value and a fair value of C1 million.

The bank debt includes a change of control clause. Acquirer X purchases target Y. It pays C6 million to the previous owner and repays the bank debt of C1 million directly to the bank.

The consideration for the business combination is the C6 million paid to the previous owner. Target Y has an identifiable liability, being the bank debt, of C1 million. Goodwill of C2 million is recognised, being the difference between the consideration of C6 million and the identifiable assets, including the bank debt, of C4 million. If the repayment of the debt had been (incorrectly) included in the consideration payable, the goodwill figure calculated would be the same.

The consideration for the business combination would include the C1 million paid to the bank, and target Y would be treated as having been acquired debt free. Goodwill of C2 million would be recognised, being the difference between the total consideration of C7 million and the identifiable assets, excluding the bank debt, of C5 million. The key difference, from a business combination perspective, is the disclosure of the net identifiable assets acquired and the total consideration payable.

Any excess in the IFRS 2 value of the replacement awards over the IFRS 2 value of the replaced awards is accounted for as an IFRS 2 employee cost in the post-combination income statement.

The element of share-based payment award charged to the postcombination income statement as employee services might or might not be spread over a vesting period.

The cost of awards is charged to the income statement over the vesting period if post-combination services are required; it is charged immediately if no post-combination services are required.

The estimate of vesting expectations could change after the acquisition date. These changes do not result in an adjustment to the consideration transferred, and they are accounted for as post-combination expenses if they are outside the measurement period. The same applies to forfeitures, modifications and the outcome of performance conditions.

Assets subject to operating lease where the acquiree is the lessor

After the date of the business combination, the off-market component of the operating lease is treated as a separate component of the asset, and it is depreciated over the period until the contract is renegotiated to market terms, which might be shorter than the asset’s life.

Reverse acquisition – presentation of consolidated financial statements

The consolidated financial statements are issued under the name of the legal parent (the acquiree for accounting terms), and so the equity structure presented in the consolidated financial statements must reflect this fact. The number and type of equity instruments issued (the legal share capital) should be retrospectively adjusted to reflect those of the legal parent. All other assets, liabilities, income and expenses are presented as a continuation of the financial statements of the legal subsidiary (accounting acquirer).

Reverse acquisitions

Reverse acquisition accounting

The following accounting treatment applies in a reverse acquisition: The assets and liabilities of the legal subsidiary (the accounting acquirer) are recognised and measured in the consolidated financial statements at their pre-combination carrying amounts. The identifiable assets and liabilities of the legal parent (the accounting acquiree) are recognised in accordance with IFRS 3 (that is, generally at fair value) at the acquisition date.

Goodwill is recognised in accordance with IFRS 3, with the consideration for the combination. The retained earnings and other equity balances recognised in the consolidated financial statements are those of the legal subsidiary immediately before the business combination.

The amount recognised as issued equity instruments in the consolidated financial statements is determined by adding the fair value of the legal parent (which is based on the number of equity interests deemed to have been issued by the legal subsidiary) determined in accordance with IFRS 3  to the legal subsidiary’s issued equity immediately before the business combination.

However, the equity structure (that is, the number and type of equity instruments issued) shown in the consolidated financial statements reflects the legal parent’s equity structure, including the equity instruments issued by the legal parent to effect the combination. The equity structure of the legal subsidiary is restated using the exchange ratio established in the acquisition agreement to reflect the number of shares issued by the legal parent in the reverse acquisition.

Example

The accounting for any income tax effects is ignored in this example. The balance sheets of entities A and B immediately before the business combination are as follows:

Entity A issues 2.5 shares in exchange for each ordinary share of entity B on 30 September 20X1. All of entity B’s shareholders exchange their shares.

Entity A issues 150 million ordinary shares in exchange for all 60 million ordinary shares of entity B. Entity A legally owns 100% of entity B. The previous shareholders of entity B own 60% (150 million/250 million) of the combined entity following the combination. The directors of entity B are appointed to six of the eight positions on entity A’s board. Entity B, the legal subsidiary, is identified as the acquirer. Both entities A and B are listed, and quoted share prices are available.

The quoted market price of each of entity B’s ordinary shares at 30 September 20X1 is C40. The quoted market price of entity A’s ordinary shares at the acquisition date is C16. The fair values of entity A’s identifiable assets and liabilities at 30 September 20X1 are the same as their carrying amounts, with the exception of non-current assets. The fair value of entity A’s non-current assets at 30 September 20X1 is C1,500 million.

Calculating the fair value of the consideration transferred for the business combination The acquisition date fair value of the equity instruments of the accounting acquirer (legal subsidiary) is generally used to determine consideration for the combination. Because the published price of the equity instruments of the legal subsidiary (entity B) is available, this is used to determine the consideration for the business combination. Entity B’s shareholders own 60% of the combined entity’s issued shares (150 million shares out of 250 million issued shares).

The remaining 40% are owned by entity A’s original shareholders. If entity B had issued additional shares to entity A’s shareholders in exchange for their shares in entity A, entity B would have had to issue 40 million shares for the ratio of ownership interest in the combined entity to be the same. Entity B’s shareholders would then own 60 million out of the 100 million issued shares of entity B and, therefore, 60% of the combined entity. Consideration for the business combination from entity B for entity A is C1,600 million (that is, 40 million shares of entity B, each with a fair value of C40).

Measuring goodwill

Goodwill is measured as the excess of the fair value of the consideration, plus any previously held interest and any non-controlling interests, over the net fair value of entity A’s identifiable assets and liabilities. There are no previously held or non-controlling interests, because all of entity B’s shareholders were third parties and exchanged their equity interests for equity interests in entity A, and all have an interest in the combined entity. Therefore, goodwill is measured as follows:

The consolidated balance sheet at 30 September 20X1 is as follows:

The amount recognised in respect of issued equity in the consolidated financial statements is determined by adding the fair value of the legal parent (C1,600 million) to the issued equity of the legal subsidiary immediately before the business combination (C600 million).

However, the equity structure appearing in the consolidated financial statements should reflect the legal parent’s equity structure, including the equity instruments issued by the legal parent to effect the combination. The equity structure of the legal subsidiary should be restated at the date of the business combination, using the exchange ratio established in the acquisition agreement, to reflect the number of shares issued by the legal parent.

That is 60 million shares × 2.5 = 150 million shares, plus the 100 million shares already in issue by the legal parent before the combination. The equity structure (that is, the number and type of equity instruments issued) at the end of the reporting period in which the business combination takes place reflects the legal parent’s equity structure.

It will therefore include the legal parent’s total equity instruments (that is, those in existence before the combination, in addition to the equity instruments issued by the legal parent to affect the combination).

Comparative information in reverse acquisition accounting

In the prior year, the comparative information presented in the consolidated financial statements should be that of the legal subsidiary. However, the disclosure of the number and type of equity instruments issued to support that equity value is restated to reflect the capital of the legal parent. This restatement is performed using the exchange ratio established in the acquisition agreement.

Local regulations might determine the presentation of share capital and other equity items at the end of the comparative period. Where no jurisdictional requirements exist, preferences of management or other relevant stakeholders would be considered. The number and type of equity instruments could reflect the capital of the legal parent. This would reflect the substance that the legal subsidiary is the acquirer, and so the prior-year figures relate only to the legal subsidiary.

Alternatively, the number and type of equity instruments could reflect the capital of the legal subsidiary. This would reflect consistency of share capital at the consolidated level with prior periods. When the transaction occurs, the legal parent will issue shares in exchange for shares in the legal subsidiary. The changes in equity structure, as a result of this share-for-share transaction, are reflected in the consolidated financial statements prospectively from when the transaction occurs. The changes in the equity structure are explained in the notes to the financial statements.

Earnings per share in a reverse acquisition

The equity structure in the consolidated financial statements reflects that of the legal acquirer, for the purpose of determining earnings per share, including the instruments used to effect the business combination.

For the purpose of calculating the weighted average number of ordinary shares outstanding (the denominator) during the period in which the reverse acquisition occurs: The number of ordinary shares outstanding, from the beginning of that period to the acquisition date, is deemed to be the number of ordinary shares of the legal acquiree (the accounting acquirer) outstanding during the period multiplied by the exchange ratio established by the business combination agreement.

The number of ordinary shares outstanding, from the acquisition date to the end of that period, is the actual number of the legal parent’s ordinary shares outstanding during that period. The basic earnings per share, disclosed for each comparative period in the consolidated financial statements following a reverse acquisition, is calculated by dividing the legal acquiree’s profit or loss attributable to ordinary shareholders in each of those periods by the legal acquiree’s historical weighted average number of ordinary shares that were outstanding, multiplied by the exchange ratio established by the business combination agreement.

There might be changes in the number of the legal acquiree’s issued ordinary shares during the comparative periods, and in the current period up to the reverse acquisition date, which would have an impact on earnings. So the calculation of earnings per share is adjusted to take into account the effect of a change in the number of the legal subsidiary’s issued ordinary shares during those periods. These rules for calculating earnings per share are illustrated below.

Example

The balance sheets of entities A and B immediately before the business combination are as follows:

Entity A issues 2.5 shares in exchange for each ordinary share of entity B on 30 September 20X1. All of entity B’s shareholders exchange their shares. Entity A issues 150 million ordinary shares in exchange for all 60 million ordinary shares of entity B. Entity A legally owns 100% of entity B. The previous shareholders of entity B own 60% (150 million/250 million) of the combined entity following the combination. The directors of entity B are appointed to six of the eight positions on entity A’s board. Entity B, the legal subsidiary, is identified as the acquirer. Both entities A and B are listed, and quoted share prices are available. The quoted market price of each of entity B’s ordinary shares at 30 September 20X1 is C40.

The quoted market price of entity A’s ordinary shares at the acquisition date is C16. The fair values of entity A’s identifiable assets and liabilities at 30 September 20X1 are the same as their carrying amounts, with the exception of non-current assets. The fair value of entity A’s non-current assets at 30 September 20X1 is C1,500 million. Entity B’s profit for the year ended 31 December 20X0 was C600 million.

The consolidated profit for the year ended 31 December 20X1 is C800 million. There was no change in the number of ordinary shares issued by entity B (the legal subsidiary) during the year ended 31 December 20X0, and during the period from 1 January 20X1 to the date of the reverse acquisition (30 September 20X1). Earnings per share for the year ended 31 December 20X1 is calculated as follows:

Step acquisitions

For step acquisitions, an acquirer discloses:

• The acquisition date fair value of the previously held equity interest in the acquiree.
• The amount of any gain or loss recognised as a result of remeasuring the equity interest to fair value, and the line item in the statement of comprehensive income in which the gain or loss is recognised.